Why protectionism fails

Exchange rate adjustment would be the principal channel through which budget deficit reduction would improve the trade balance. Just as a run-up in federal borrowing pushed up interest rates domestically—which in turn pushed up the value of the dollar by attracting capital from abroad—a significant reduction in the federal budget deficit would depress interest rates and the value of the dollar, making U. But the day of reckoning due to the excess consumption enjoyed in the s cannot be postponed forever.

The only way our nation can compensate for an erosion in the value of the dollar is to raise productivity. Reversing overall trade patterns will be not only politically difficult but also time consuming. Indeed, despite its free trade rhetoric, the Reagan administration has resorted increasingly to protection in the worst way possible, by using quotas and sanctioning the creation of cartels.

Why has an administration so philosophically committed to free trade caved in to the clamor for protection? The first, the so-called escape clause, allows domestic industries to receive a temporary haven from imports when they can prove to the U.

International Trade Commission ITC that the imports cause them, or threaten to cause them, serious economic injury. Although this provision of U. An industry can win its case before the ITC but still be denied relief by the president, which encourages it to run to Congress for permanent protection as the shoe and copper industries have done in the last two years.

In addition, the law has allowed the president to authorize temporary import relief in the form of quotas as well as tariffs; the latter distort trade flows less and, unlike quotas, also raise revenue for the government.

The second safety valve—trade adjustment assistance TAA for companies, workers, and communities hurt by import competition—has been rendered increasingly ineffective because of severe funding cutbacks over the past five years.

Yet even in its heyday, TAA delayed adjustment, particularly for displaced workers, who were merely given extended unemployment compensation payments without encouragement to find other employment. Declining tariffs should be made the sole form of temporary relief for industries seriously damaged by import competition. This would make the escape clause more cost effective. In addition, all existing quotas and other quantitative restrictions should be converted to their tariff equivalents by auction; that is, rights to import products within quota ceilings would be sold to the highest bidders.

Tariff rates would then be scheduled to decline over time. The revenue raised by these tariffs would be earmarked for workers affected by imports. An affirmative injury finding by the International Trade Commission should cause liberalized standards to be invoked when the government is assessing proposed mergers of companies in beleaguered industries unprotected by quotas, as recently recommended by the Reagan administration. If the ITC judges an industry to be seriously damaged by imports, there is little worry that mergers will lead to imperfect competition.

Trade adjustment assistance should automatically be extended to displaced workers, but only in such a way that the benefits promote, not delay, adjustment. The primary TAA component should consist of insurance against loss of wages.

That is, displaced workers should be compensated for some proportion of any wage reductions suffered in obtaining new jobs. This would encourage them to find and accept new employment quickly. A second component could provide extended unemployment compensation to workers living where the unemployment rate is much higher than the national average.

Relocation allowances and help in retraining could also form part of this program. Federal loans for retraining would carry repayment obligations tied to future earnings and collected automatically through the income tax system. Even under very conservative assumptions, conversion of existing quotas into declining tariffs would readily finance this program of trade adjustment assistance for at least a decade.

As a result, there would be no financial pressures to impose new tariffs to fund the program, although the president would still be authorized to grant tariff remedies to domestic industries that could prove to the ITC that they merit relief. A new insurance mechanism would ease the pain of economic dislocation in communities—a voluntary insurance system by which municipalities, counties, and states could protect themselves against sudden losses in their tax bases not produced by a reduction in tax rates.

Under such a program, participating government entities would pay an insurance premium, much like the premiums in corporate unemployment compensation, for a policy that would compensate for losses in the tax base caused by plant closures or large layoffs. We will not be able to correct our trade imbalance until our national spending patterns change. But in the meantime, we must do a far better job of easing the difficult dislocations that this persistent imbalance has caused.

Murray L. Weidenbaum and Michael C. The problem is that a nation may have a good intention of helping its industries be competitive abroad while its citizens pay higher prices at home. A trade war among nations. A serious problem with trade protectionism is that nations will take reciprocal action if there are trade protection policies put into effect. The problem here is that nations will retaliate if they cannot sell their goods and products in markets where they normally could.

For example, the United States and Japan, long-time allies, both politically and militarily since the end of World War II, have invoked tariffs and administrative trade policies against each other. This has ended up costing the consumers of the respective countries billions of dollars in increased costs and limited consumer choices. A trade war will ultimately mean increased import costs as manufacturers and producers must pay more for equipment, commodities, and intermediate products from foreign markets.

According to a study by the International Monetary Fund IMF , a permanent 10 percent increase in American tariffs on imports from all parts of the globe will result in a permanent 1 percent decrease in real GDP. The most famous trade war reprisal that occurred in the history of the United States was the Smoot-Hawley Act in June of Here, President Herbert Hoover signed a tariff bill that raised taxes on many agricultural products and goods causing retaliation by other nations. While the act was intended to protect American companies and industries, it increased tariffs by an average of 20 percent on more than 20, imported products and goods.

This ultimately caused global trade to drop by 67 percent and American exports to fall as much as 75 percent. Arthur Guarino is an assistant professor in the Finance and Economics Department at Rutgers University Business School teaching courses in financial institutions and markets, corporate finance, investments, and financial statement analysis.

He writes articles dealing with finance, economics, and public policy. Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinion of FocusEconomics S. Views, forecasts or estimates are as of the date of the publication and are subject to change without notice. This report may provide addresses of, or contain hyperlinks to, other internet websites. FocusEconomics S.

Major Economies. South-Eastern Europe. Sub-Saharan Africa. Central America. Monetary and Financial Sector. Precious Metals. Region Reports. Trump has been targeting trade as the culprit behind American job losses. Partly, this claim is backed by the empirical literature. For instance, Acemoglu et al. Furthermore, Ebenstein et al. Oldenski , however, argues that the wage effect of offshoring is distributed unevenly, with gains for the most highly-skilled workers and relative losses for middle-skilled workers.

This is in line with the general observation of a polarised American labour market see Box 1. But Trump has been ignoring one big elephant in the room: automation also has been an important reason why American jobs have been shredded Autor et al. Declining costs of ICT and fast-increasing processing power have increased options to automate cognitive-routine tasks. Think about office and administrative supporting jobs.

Empirical research shows that automation might be far more important in explaining polarisation of the US labour market than trade. Hicks and Devaraj show that 88 percent of US job losses between and is the result of productivity growth due to e.

The bottom-line is: Trump can impose trade barriers, but he cannot reverse technological progress. The fact that trade barriers are unlikely to restore jobs lost in the past decades should refrain Trump from turning to large-scale protectionist measures. So, what if Trump does agree with the conclusions regarding the negative impact of protectionism on corporates, but is more concerned about the negative impact of globalisation on certain groups of workers?

What if he is more concerned about being able to keep some of his campaign promises and this makes trade a clear target given the difficulties he is facing in terms of domestic fiscal reform?

In short: what is the economic impact on the US and world economy if Trump decides to implement protectionist trade measures anyway. To answer this question, we have used the macro-econometric trade model NiGEM to run two scenarios.

In the first scenario, we assume Trump decides to impose an additional uniform import tariff of 20 percent on all products and services imported in the US, in the third quarter of The results of scenario 1 are illustrated in Table 2. In the US, for example, the economy would grow by 1.

We currently expect the US economy to grow by 2. Hence, in case of a uniform import tariff the US economy would grow by 1. In the rest of the world we see that countries with a large internal market, like China and Germany, are relatively shielded from external trade shocks. Small open countries like the Netherlands and countries that have the strongest trade ties with the US, like Canada and Mexico, are hit relatively hard.

Canada suffers more than Mexico, as the Canadian economy depends more on exports than the Mexican economy. So why do trade barriers have a negative effect on GDP? The 20 percent additional tariff leads to higher import prices in the US and accordingly to higher domestic inflation.

Not only the price of imported consumer goods rises, but also the price of intermediate inputs. This will result in higher export prices, as production becomes more costly. Higher import and export prices lead to lower private consumption, lower investment, and lower export and import growth. On top of that, higher inflation feeds into higher interest rates.

Higher inflation will force the Fed to hike its monetary policy rate to stem inflation. Of course, the Fed would take into account the fact that it is dealing with cost-push inflation and not demand-pull inflation. As such, in order to prevent significant damage to the economy, the Fed will calibrate its policy rate on nominal GDP developments nominal GDP targeting instead of the usual mix of nominal GDP and inflation Taylor rule.

Obviously, inflation developments will still influence Fed policy, as nominal GDP growth also depends on inflation. In any case, higher interest rates discourage private consumption borrowings and investment. At the same time, higher interest rates increase demand for dollar assets. Consequently, the US dollar appreciates, slightly lowering the negative impact of the import tariffs. The upshot is that the US economy suffers.

The same holds for economic growth in the rest of the world. As imports in the US are more expensive, export growth in other countries slows. Lower export growth also feeds into, amongst other things, lower investment, employment and consumption growth. As lower growth in the rest of the world also lowers import demand in the rest of the world, the US economy takes another hit in the second round.

In scenario 1, we have only imposed an additional import tariff in the US. But protectionist measures rarely stay unanswered and countries tend to retaliate. For instance, in response to the softwood lumber levy, Canadian officials have announced that the government will look at options to cease shipment of thermal coal from ports in British Columbia.

These are small-scale threats, but a large-scale retaliation by China to US-imposed trade barriers could have a devastating effect on the US economy. To estimate the effect in case of retaliation, we ran a second scenario using NiGEM. The US again imposes an additional uniform import tariff of 20 percent in the third quarter of This is usually through tariffs, quotas, taxes, and other trade restrictions. It is also useful to create standards and norms across different countries, particularly for things like intellectual property law recognition, which enables businesses to operate across borders.

There are quite a few international trade agreements, some of which are more formal than others. The trade agreements below provide a fairly comprehensive overview of the current international trade environment:.

In many ways, the WTO is more complex than other international trade agreements because it incorporates a variety of smaller agreements into a larger framework. The WTO includes upwards of 60 different agreements alongside official members and 25 observers. The WTO performs several objective functions as well if trade disputes arise, acting as a framework for assessing appropriate international trade practices.

This map shows how successful this has been on a global scale. Every WTO member gets charged the lowest tariff that an importer charges any other member. Unlike the WTO, which is an entirely global approach, most international agreements stem from geographic proximity.

NAFTA is a trilateral agreement between the United States, Canada and Mexico designed to minimize any trade or investment barriers between any of these countries primarily in the form of tariffs.

Generally speaking, the United States demonstrates a trade deficit with these countries relative to goods and a surplus relative to services. The United States also demonstrates high and fast-growing foreign direct investment FDI in both regions.

There has been a great deal of controversy surrounding this trade agreement. Agriculture is not included in this agreement, and is often a tough point of discussion for the WTO as well. Mexico is also a point tension due to the fact that it is developing economically compared to the U. These agreements demonstrate some of the validity behind trade protectionism and isolationism as discussed in other atoms in this chapter. Developing nations gaining access to capital investment and export agreements is the central outcome of APEC, driving economic growth through controlled global expansion.

Privacy Policy. Skip to main content. International Trade. Search for:. Arguments for and Against Protectionist Policy. National Security Argument National security protectionist arguments pertain to the risk of dependency upon other nations for economic sustainability. Learning Objectives Evaluate the arguments in favor of the use of trade protectionism in the security industry.

Key Takeaways Key Points Economic interdependence and globalization has resulted in a unique capitalistic system, where each country is largely dependent upon other countries for economic sustainability.

This highlights the risk of conflict harming an economy. Indeed, trade during wartime can be a substantial threat to a nation, as economic levers such as sanctions can be utilized. All of these economies struggle d against harsh economic sanctions. Key Terms sanction : A penalty, or some coercive measure, intended to ensure compliance; especially one adopted by several nations, or by an international body. Self-sufficiency : Able to provide for oneself independently of others.

Infant Industry Argument Economic markets are inherently competitive and newer economies are vulnerable to their more developed counterparts in other countries.

Learning Objectives Discuss the use of trade protectionism to promote new industries. Key Takeaways Key Points Trade protectionism is national policies restricting international economic trade to alter the balance between imports and goods manufactured domestically through import quotas, tariffs, taxes, anti-dumping legislation, and other limitations.

The primary advantage to countries with higher economic power and bigger corporations is simply economies of scale, which infant industries in developing countries often protect against. The United States was employing heavy tariffs to protect their fragile economic system as the economy began to achieve autonomy after British rule, which proved effective. The argument is that free markets add value on a global level, while protectionism confines economic value to the nation employing it.

Key Terms Nascent : Emerging; just coming into existence.